American Depositary Receipts (ADR) Meaning
American Depositary Receipts (ADRs) are the stocks of the foreign companies which are traded in the American markets and are purchased by the investors in U.S. dollars during the normal trading hours in the U.S. market through the brokers which allows the people of America to invest in foreign companies.
The ADR was firstly created in the year 1927 by the J.P. Morgan in which Americans were allowed to invest in Selfridges’s shares, which is a British department store.
Presently there are thousands of ADRs available, which represents the shares of different companies located in different countries. According to the Securities and Exchange Commission (SEC), it is more convenient for the investors to own ADRs in place of the foreign stock itself because they have protection and transparency in case of ADRs facilitated by the US securities regulation.
Types of ADRs
There are two basic types –
Type #1 – Sponsored ADR
The bank issues the Sponsored ADRs on behalf of the foreign company where there exists the legal arrangement between the two parties. In this case, the transactions with the investors will be handled by the bank while the cost of issuing ADRs and control of ADR will be of foreign company.
These ADRs are registered with the Securities and Exchange Commission (SEC) (except sponsored ADRs lowest level) and are traded on the major stock exchanges of the US.
Type #2 – Unsponsored ADR
Unsponsored ADRs are the shares that are traded on the over-the-counter market (OTC). A bank issues unsponsored ADRADRADR (American Depository Receipts) is a financial instrument traded in US markets and are issued by US banks. ADRs are listed on the stock exchange and can trade like other stocks. according to demand in the market where a foreign company under consideration has no participation or formal or legal agreement with a depository bank. Such ADRs are never included for the voting rights.
Example of the American Depositary Receipts
Let’s consider an example of the German company named Volkswagen shares of which trades on the New York Stock Exchange. After the compliance of various laws, it got listed on the American stock exchange. Now, investors in America through the stock exchange can invest in Volkswagen. In case apart from the US market, if Volkswagen’s shares are listed in other country’s stock markets as well, then it would be termed as the GDR.
- The issuer of the ADRs can get access to the capital available in the market of the US and get the diversified base of the shareholders (US shareholders).
- ADR makes it easy for the issuer to go for Merger and Acquisition activities as they can use ADR as the currency for the acquisition.
- For the investor, ADRs are easy to use as they can buy and sell the shares of the other country’s company like their own country company. Also, there is no need for a new broker or to open a foreign brokerage accountBrokerage AccountA brokerage account is a taxable investment account in a brokerage company where a person deposits its assets and instructs the company to trade in shares or bonds on their behalf. In addition, the company deducts some brokerage or commission. as investors can use the same broker with whom they normally deal.
- An investor gets the opportunity to diversify their investment portfolio on a global scale.
- Everything is done as per the US working. The investors purchase ADRs in US dollars; dividends are given in dollars, traded during the normal trading hours in the US, and are subject to similar settlement procedures as that of the American stocks.
- This gives more accessibility of research and information to the investors, and investors can customize their portfolio according to their requirements like which countries they are interested in or which sector, etc.
- The unsponsored ADRs may not be compliant with the Securities and Exchange Commission (SEC)
- The investors might have limited companies for the selection as all the foreign companies are not available as ADRs.
- For the purpose of diversification, an investor needs enough capital investmentCapital InvestmentCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc.; otherwise, it will not be possible to create a properly diversified portfolio.
- The investor might have to face the double taxationDouble TaxationDouble Taxation is a situation wherein a tax is levied twice on the same source of income. It usually occurs when the same income is taxed both at corporate as well as at the individual level. in case the dividend is taxed differently, as ADRs dividends received may be subject to the tax in the home country of the company.
- Before the investment in ADRs, one should consult with both a tax advisor and the financial advisor to understand the implications of the portfolio in which the person is planning to invest its capital. Also, as it involves international investing, initially, one should go with international mutual fund present until one gets the good knowledge about the same.
- There are several unique differences between American Depositary Receipts and foreign stocks or the traditional US stocks, which one should consider before making any investment. Like taxes on the dividendDividendDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company. may be charged differently. In the case of the US stocks, taxes charged will be in the US only. Whereas, in the case of ADRs, dividends may be subject to tax in the home country of the company also. In that case, in order to avoid double taxation, investors might have to apply for either refund from a foreign country or apply for credit against their US taxes.
Thus it can be concluded that the American Depositary Receipts provide the opportunity to the investors of the U. S. to trade in the shares of the foreign companies easily and conveniently. They also give the opportunity to the investors for the diversification of their portfolioDiversification Of Their PortfolioPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio. as they can invest in companies that are not based in their home country America.
With the help of American Depositary Receipts, investors invest in the companies which are located in the emerging markets where they can maximize their profit out of the money investedOut Of The Money Invested”Out of the money” is the term used in options trading & can be described as an option contract that has no intrinsic value if exercised today. In simple terms, such options trade below the value of an underlying asset and therefore, only have time value. by them. So the American Depositary Receipts remove the restrictions of the Americans of investing only in the home country.
This article has been a guide to What is American Depositary Receipts (ADRs) and its meaning. Here the top types of ADRs along with examples, advantages, and disadvantages. You can learn more about Investment Banking from the following articles –